World leaders are expected to take a softly-softly approach to regulating the so-called shadow banking sector when they meet in Russia next month to avoid damaging the flow of finance to the global economy.
While governments have cracked down on risk-taking by traditional banks in the wake of the financial crisis, the shadow banking sector, an assortment of financial intermediaries that handle $60 trillion of transactions a year — roughly the same size as the world economy — remains a source of systemic risk for taxpayers.
Such intermediaries, which include hedge funds, money market funds and structured investment vehicles, provide credit to the financial sector, but, unlike banks, have no access to central bank support or safeguards such as deposit insurance and debt guarantees.
They often rely on short-term funding sources, such as the repurchase or repo market, in which borrowers sell the lender a security as collateral and agree to buy it back later at a set time and price.
At their meeting on September 5-6 the Group of 20 economies (G20) will endorse reforms but stop short of rushing through far-reaching changes because of the role shadow banking activities play in providing liquidity to the still fragile banking sector, according to people familiar with the G20’s work.
Banks’ use of off-balance-sheet vehicles to repackage and sell on US subprime mortgages kickstarted the financial crisis in 2007, but such shadow banking activity, known as securitisation, is viewed as key to helping wean banks off central bank money and fund themselves.
“There is a fuss about this because the crisis of 2008 was essentially a shadow banking crisis, as most of the lending in the US and UK was financed through short-term repo,” said Alistair Milne, professor of financial economics at Loughborough University.
“The shadow banking reform is more about not getting into trouble in the future, so they can take a bit more time,” added Milne, a former Bank of England and UK Treasury official.
Regulators pushed through a new regulatory regime for traditional banks — the Basel III framework, which forces them to hold more capital — in record time.
There is growing appreciation at the G20